MS Windows and OEM sales slow in $6bn Q2

Microsoft still makes buckets, but the slope seems to be getting shallower

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Microsoft's Q2 results, announced last night, show a slowing of both revenue, net income, and income per share, but as usual, this is not the way it will be reported. With Microsoft's revenue being closely correlated with new products and PC sales, it is more logical to compare sequential quarters rather than year-earlier quarters, whether that's the way Wall Street does it or not, since it gives a better picture of trends in a fast-moving industry. But even year-on-year, there is no doubt that Microsoft's growth rate is slowing substantially. Revenue was $6.11 billion for the second quarter ending 31 December, up 14 per cent sequentially and 18 per cent on the year-earlier quarter. Net income was $2.44 billion, up just 11 per cent sequentially and 22 per cent on the year-earlier quarter. Perhaps the most significant observation is that Q1 results were also around a third down on the previous quarter, so there is a marked trend downwards. Earnings per share were 44 cents, with CFO John Connors suggesting in the conference call that Q3 could see only 41 cents for the next two quarters. Of course the game is to beat expectations and get the usual headlines to impress investors. Microsoft's cash and fluid investments were $17.8 billion, little changed in the quarter. During the quarter, Microsoft bought 43 million of its own shares for $3.8 billion at an average price of $89. The main trading trend was that Windows sales were down more than expected (an increase of just 6 per cent year-on-year), but applications - mostly Office - were up more than expected. Connors put this down to a mixture of Y2K (resulting in PC sales being down) and Windows 2000 hold-offs. OEM revenue was up only 4 per cent year-on-year, and there has been a decline of 35 per cent to 31 per cent in OEM revenue as a percentage of business, caused of course by Microsoft's corporate licensing programmes. The consumer division was still making a loss and is expected to make a loss next quarter Connors said, despite a 23 per cent increase year-on-year. Consumer revenue is expected to pass the $1 billion mark, but the losses are not being disclosed. The Caldera settlement had to be included in Q2 because of accounting rules, although it came after the end of the quarter. Connors would not be drawn, even by Rick Sherlund of Goldman Sacks, to say anything more than it cost Microsoft three cents a share. However, the accounts show that "General and administrative expenses" went up from $143 million to $506 million between the first and second quarters of the financial year. Connors said that the increase was primarily from the Caldera settlement, but there were also higher legal fees, and part of the increased cost of stock option charges resulting from accounting for social factors, as was now required. Examining this, we know that legal fees for US v Microsoft would have been lower in the quarter, as less work was needed. Other cases were also quieter, except for Caldera v Microsoft, so we can reasonably discount any non-Caldera-related legal costs. The stock option costs would be just for employees in the general and administrative division, which has relatively few people, so let's estimate $50 million (out of $400 million for the whole company) for this. This would make the cost of the Caldera settlement to Microsoft perhaps $350 million, but hardly less than $300 million, which is considerably above the $150-to-$250 million estimates that were being made on the basis of 3 cents/share that Microsoft was budgeting. As we pointed out at the time, Microsoft did not say that the cost was actually just 3 cents/share, but only said what it would do to its accounts. It should be remembered that the accounts Microsoft released yesterday are unaudited, and that it is the annual accounts that are audited. In the miscellaneous information department, it was said in the conference call for financial analysts that SQL outsold Oracle by three to one, so far as units were concerned, but of course SQL is much less expensive. No precise date was given for the release of SQL Server 2000, or Exchange Server 2000, other than "in the next nine months". WebTV was said to have more than a million subscribers. There is a new contract in place in California and Oregon, following a Microsoft legal error, since in those states users were able to buy kit and return it, but still hang on to a $400 rebate that Microsoft was offering if the user signed up to MSN and bought some kit. Windows 2000 would result in no spike in consumer sales, Connors said, with related revenue in the next quarter being small as the product will only appear half-way through the quarter. Although there have been a few pre-release sales (the revenue from which will not be recognised until after the official release, Connors said), it is strange that Microsoft has been talking in terms of there being any revenue, since as Connors admitted during the conference call, it takes at least 30 days to get the revenue from OEMs. Connors was looking for strong sales in Q4 as a result of Windows 2000, which contradicted his guidance about income per share in the next two quarters. Connors was pressed to break out sales of Office from non-Office sales (mostly tools), but he declined to do this. Nor would he be drawn on OEM prices for Windows 2000, other than to agree that they would be "similar" to NT4 pricing. CEO Steve Ballmer's contribution to the announcement was to say that "Software is the key to the future", which reminds us of the Chinese aphorism that prediction is difficult, especially with respect to the future. ®